With Derivatives, you can Bet on anything — Even the Weather!

(9 am. – promoted by ek hornbeck)

Introduction To Weather Derivatives

by Felix Carabello, Associate Director, Environmental Products, Chicago Mercantile Exchange

Weather: Risky Business

It is estimated that nearly 20% of the U.S. economy is directly affected by the weather, and that the profitability and revenues of virtually every industry – agriculture, energy, entertainment, construction, travel and others – depend to a great extent on the vagaries of temperature. […]

In a 1998 testimony to Congress, former commerce secretary William Daley stated, “Weather is not just an environmental issue; it is a major economic factor. At least $1 trillion of our economy is weather-sensitive.”


If there were only some way, to “Hedge that Bet” — against the ever present risk of Foul Weather.

No WorriesWhere there’s a Market Risk, there’s always a Wall Street Way!

We still live largely at the mercy of the weather. […]

However, the inception of the weather derivative – by making weather a tradeable commodityhas changed all this.


Temperature as a Commodity

Until recently, insurance has been the main tool used by companies’ for protection against unexpected weather conditions. But insurance provides protection only against catastrophic damage. Insurance does nothing to protect against the reduced demand that businesses experience as a result of weather that is warmer or colder than expected.

In the late 1990s, people began to realize that if they quantified and indexed weather in terms of monthly or seasonal average temperatures, and attached a dollar amount to each index value, they could in a sense “package” and trade weather. In fact, this sort of trading would be comparable to trading the varying values of stock indices, currencies, interest rates and agricultural commodities. The concept of weather as a tradeable commodity, therefore, began to take shape.


In general, weather derivatives cover low-risk, high-probability events. Weather insurance, on the other hand, typically covers high-risk, low-probability events

Introduction To Weather Derivatives

by Felix Carabello, Associate Director, Environmental Products, Chicago Mercantile Exchange

Psssst!  Dudes, would you like to buy a few Rainy Days? … We got a Truckload of them we need to Unload!

Weather derivatives


Farmers can use weather derivatives to hedge against poor harvests caused by drought or frost; theme parks may want to insure against rainy weekends during peak summer seasons; and gas and power companies may use heating degree days (HDD) or cooling degree days (CDD) contracts to smooth earnings. A sports event managing company may wish to hedge the loss by entering into a weather derivative contract because if it rains the day of the sporting event, fewer tickets will be sold.

Heating degree days are one of the most common types of weather derivative. Typical terms for an HDD contract could be: for the November to March period, for each day where the temperature falls below 18 degrees Celsius keep a cumulative count of the difference between 18 degrees and the average daily temperature. Depending upon whether the option is a put option or a call option, pay out a set amount per heating degree day that the actual count differs from the strike.


There is no standard model for valuing weather derivatives […] Typically weather derivatives are priced in a number of ways [including]:

Business pricing

Business pricing requires the company utilizing weather derivative instruments to understand how its financial performance is affected by adverse weather conditions across variety of outcomes (i.e. obtain a utility curve with respect to particular weather variables). Then the user can determine how much he is willing to pay in order to protect his/her business from those conditions in case they occurred based on his/her cost-benefit analysis and appetite for risk.

In this way a business can obtain a ‘guaranteed weather’ for the period in question, largely reducing the expenses/revenue variations due to weather.

Alternatively, an investor seeking certain level or return for certain level of risk can determine what price he is willing to pay for bearing particular outcome risk related to a particular weather instrument.


Must be nice to be able to ‘guaranteed weather’ — maybe these Derivative Resellers, can get together with the Climate Change crowd — and simply “trade away” the cost of any “Adverse Weather”, we all are creating, in the long-run for Future Generations?

Because fortunately unfortunately you can take a Derivative out on about ANYTHING! … even on those risky Sub-Prime Mortgages (CDOs).

Wherever there’s a Market Risk, Wall Street will find a way to turn it into a Quick Buck!‘Chronic Gamblers’ are funny that way!

The Bet That Blew Up Wall Street   (pg 1 of 4)

Steve Kroft — 60 Minutes

On Credit Default Swaps And Their Central Role In The Unfolding Economic Crisis

Anyone with more than a casual interest in why their 401(k) has tanked over the past year knows that it’s because of the global credit crisis. It was triggered by the collapse of the housing market in the United States and magnified worldwide by the sale of complicated investments that Warren Buffett once labeled financial weapons of mass destruction.

They are called credit derivatives or credit default swaps.

As correspondent Steve Kroft first reported last fall, they are essentially side bets on the performance of the U.S. mortgage markets and some of the biggest financial institutions in the world – a form of legalized gambling that allows you to wager on financial outcomes without ever having to actually buy the stocks and bonds and mortgages.


In other words, three of the nation’s largest financial institutions had made more bad bets than they could afford to pay off. Bear Stearns was sold to J.P. Morgan for pennies on the dollar, Lehman Brothers was allowed to go belly up, and AIG, considered too big to let fail, is on life support thanks to a $180 billion investment by U.S. taxpayers.

It’s legalized gambling. It was illegal gambling. And we made it legal gambling … with absolutely no regulatory controls. Zero, as far as I can tell,” Dinallo says.

“I mean it sounds a little like a bookie operation,” Kroft comments.

“Yes, and it used to be illegal. It was very illegal 100 years ago,” Dinallo says.

The problems with Gambling are many.

But in an Economic context, when reckless Gamblers, are allowed to simply “swap away” the ultimate Cost, of any real Risk, … with NO light-of-day oversight, to ensure everything’s above board —

Well, you end up with what we got now:   fractured 401k funds, a broken Housing Market, too many Bankers who refuse to lend to Small Business … and a Boatload of Investment Firms Bookies, all claiming “it was the other guy’s fault.”

Buyer Beware!“, you know, it’s just OUR “Free Market” — in action!

Free for Whom?” … should always be the follow up question.

Certainly NOT “Free” to the average Taxpayers (and Homeowners) who end up bearing the brunt of most of that Economic Risk, when those reckless Derivative Bets, inevitably go bad … as speculative Bets, usually do.    (and calling it a “critical” Bail Out, does NOT — make it ALL OK.)

Why do you think they call it “Betting” anyways?     (Someone ALWAYS loses!)

Psssst!  Sista, would you like to buy a few Alt-A CDO’s? … We got a Truckload of them we need to Unload! … All these undervalued Mortgage-Bond-Instruments, AREN’T going to Re-write themselves, ya know …

Get em, While they’re a steal!

It’s a limited time offer only … step right up … (and be sure to bring your credit cards …)



    • jamess on April 21, 2010 at 14:11

    at our expense, using CDO Derivatives.

    kind of like this:

    ” […] The of the toxic assets that have plagued Wall Street Goldman created one of these instruments. On behalf of the hedge fund manager John Paulson who really has a negative view on the housing market, and he wanted to place bets that would reflect that view. So Goldman constructed this for him and gave him a lot of influence over what went into that mortgage product which was called in media collateralized debt obligation. (CDO)”

    ” Well how would John Paulson influence that CDO, what might he do?”

    ” Well what a CDO, it is — a collection, of Mortgage bonds. And in fact actually gets more complex than that because it’s side bets on mortgage bond collection of side bets on mortgage bonds and what Paulson did was: Select the losers […]

    So it’s essentially like, going through the entire Major League Baseball roster and picking up all the 200 hitters and putting them in your roster.”

    It’s like Picking out the worst hitters. And putting them in a roster and then — betting the team won’t win.”

    “Yeah that’s right.”

    NRP Report


  1. naturally, like many other derivatives markets.  Unfortunately they survived the demise of the company.

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